In May, Federal Reserve Chairman Ben Bernanke mentioned the
potential for the Fed to begin tapering their asset purchase program,
Quantitative Easing (QE). Since then,
the financial markets have been obsessed with tapering and – more specifically
– how it may affect interest rates.
Many Fed watchers have predicted the Federal Reserve will
begin to taper QE sometime in early-to-mid 2014. After the latest jobs report, there is talk
that the Fed may reduce asset purchases sooner rather than later.
On December 6th, the Bureau of Labor Statistics
released the November jobs report, which showed nonfarm payroll employment grew
by 203,000. The jobs numbers were
significantly better than expected and lowered the unemployment rate sharply
from 7.3% to 7.0%.
The seemingly good economic news propelled the stock market
higher. That same day, the Dow Jones was
up nearly 200 points and the S&P 500 rallied back up above 1,800.
The positive job numbers led many to forecast a QE taper
starting at the Fed's last meeting of 2013.
Will the Fed start to taper in December?
Probably not. Here's why:
Fed members have cited needing to see 4-6 month job creation of at least 200,000 before tapering.
When Bernanke first mentioned QE tapering back in May, he said a 4-month average of at least 200,000 of monthly job growth was necessary to justify reducing the pace of asset purchases. Charles Evans, Chicago Fed president, cited wanting to see job growth of 200,000 for at least six months with "high confidence" it could be maintained. Eric Rosengren said he needs to see consistent monthly increases exceeding 200,000.
The chart below shows the nonfarm payroll data since January 2013.
When Bernanke first mentioned QE tapering back in May, he said a 4-month average of at least 200,000 of monthly job growth was necessary to justify reducing the pace of asset purchases. Charles Evans, Chicago Fed president, cited wanting to see job growth of 200,000 for at least six months with "high confidence" it could be maintained. Eric Rosengren said he needs to see consistent monthly increases exceeding 200,000.
The chart below shows the nonfarm payroll data since January 2013.
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| Figure 1: 2013 US Non-Farm Payrolls & Unemployment Rate |
From April to July, the 4-month moving average was just over
172,000. After November's numbers, the
4-month average crossed the 200,000 mark to 204,000. However, the 6-month average is 180,000 which is still well short of 200,000. November was the first month with over 200,000 jobs created since August and only the third in all of 2013.
Monthly job growth of 200,000 is a trigger point, but it may not be sufficient for the Fed to reduce asset purchases. Fed officials need to see enough data to give them confidence that employment growth can be sustained. We have said all along that the decision to taper would be data-driven and we still stand behind that. While the trend is positive and increases the likelihood of a Fed taper, we don't believe the data provides high enough confidence of sustainability.
Monthly job growth of 200,000 is a trigger point, but it may not be sufficient for the Fed to reduce asset purchases. Fed officials need to see enough data to give them confidence that employment growth can be sustained. We have said all along that the decision to taper would be data-driven and we still stand behind that. While the trend is positive and increases the likelihood of a Fed taper, we don't believe the data provides high enough confidence of sustainability.
2. Participation Rate Falling
As Bernanke said at his press conference on September 18th, the unemployment rate does not necessarily do a great job of measuring the state of the labor market overall. The participation rate, which measures the active portion of
labor, provides an additional perspective. It only includes the number of
people that are either currently working or pursuing work – eliminating those
who are no longer actively searching for jobs.
The chart below graphs the participation rate from 2003 to 2013.
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| Figure 2: US Participation Rate Sinec 2003 |
From 2003 to 2008, the participation rate fluctuated around
66%. Since 2009, it has fallen to
63%. In 2013, the participation rate has
dropped farther from 63.6% in January to 63% in November. With less people participating in the
workforce, the unemployment rate is artificially reduced.
If the unemployment rate had remained constant, the
unemployment rate would currently be 7.8% – much higher than the current 7.0%
level and much farther from the Fed's trigger point of 6.5%. The Fed knows this and we don’t believe they
will start to tighten monetary policy until they see real economic improvement.
3. Deflationary Fears
As we discussed in our post about the economy, the Fed is
much more concerned about the possibility of deflation than it is about
inflation. October’s core inflation rate
was 1.68%, down from 1.76% in August. With
core inflation well below the Fed’s target of 2 to 2.5% and trending lower, it is
unlikely that the Fed will decide for an early taper.
With low probability of a Fed taper and no inflationary
pressure, we expect interest rates to stay muted headed into 2014 and don't see
any significant movement in rates until at least 2015. The bond market's reaction to the
better-than-expected jobs data seems to indicate that fixed income investors agree
with us. In two days of trading
following Friday’s report, the 10-year U.S. Treasury yield dropped from nearly
2.9% to under 2.8%.
Without any major upward tick in long-term (10+ year)
interest rates, investors still have very few places to put money. Price-to-earnings ratios are well within
historical norms, especially considering we are in such a low interest rate
environment. As rates continue to stay
low, we anticipate cash on the sidelines and in fixed income will continue to
move towards equities. While investors
are unlikely to see another year like 2013, continued low interest rates and
improving global economies will keep the bull market alive in 2014.
